Could changing your accounting date help reduce your tax bill?

Unincorporated businesses, so sole traders and partnerships, have free choice when it comes to selecting their accounting date.

Some will choose a date for commercial reasons – for example to fit in with a cyclical trading pattern or to fall in a slack period – and for others the logical choice may be 5 April [or 31 March] to align with the tax year.

Choosing the right year end will not only make life administratively easier for a business, but choosing a year end other than 5 April [or 31 March] can give a cash-flow advantage and can create outright tax savings, if the circumstances suit.

Depending on the choice of accounting date, new businesses and individuals joining existing partnerships may see some of their profits taxed twice because of special rules which dictate when and to what extent business profits are assessed; profits taxed twice are known as “overlap profits”.

Businesses trading when self assessment was introduced in 1996/97 may also be carrying overlap profits and changing a business’ accounting date can also cause profits to be doubly assessed.

The value of any doubly assessed or overlap profits is subsequently carried forward and given as a tax-reducer when a business ceases, when an individual leaves a partnership and on certain changes of accounting date.

The thought of profits being taxed twice naturally gives rise to a common misconception that overlap profits are bad, which we don’t fully agree with; the rules giving rise to overlap profits relating to a change of accounting date can be used to your advantage, which is illustrated in the very simple case study below.

That said, if you are carrying overlap profits, you must recognise that most, if not all, of these profits will have suffered higher rate tax on their creation, therefore, so as not to be out of pocket, it is important to be mindful of one’s income levels and one’s marginal rate of tax.  Individuals whose income is running down – perhaps older individuals who are phasing into retirement – should consider whether they can utilise their overlap profits at a time when they remain higher rate taxpayers, particularly as more people leave their pension funds untouched as a means of inheritance tax planning.

In addition, overlap profits are not augmented for inflation, so profits doubly assessed in 1996/97 are, in real terms, probably worth less, which is another reason to consider making use of them now, perhaps by way of changing your business accounting date.

Tax Tip – if you’re carrying a material level of overlap profit, be aware of your future intentions and likely income levels, and aim to use overlap profits when you remain a higher rate taxpayer.  You don’t have to cease trading to achieve this, as overlap profits can be accessed by a simple change of accounting date.

Back to the case study, which illustrates how a change of accounting date can benefit a business:

  • Partnership with a 30 April year end went from being highly profitable to being loss making, almost overnight.
  • A 30 April year end is great, as it allows a lengthy period between making profits and paying tax on them, however, where a business falters as above, tax becomes payable when the business has no cash [unless the business has a very prudent and very disciplined tax provision policy].
  • In this case, changing the year end to 31 March enabled the partners to utilise their significant overlap profits and it also enabled earlier access to trading losses; this created significant cash flow benefits for the business and it also got rid of the overlap profits.
  • A few years later the business returned to significant profitability, almost as spectacularly as it became loss making, resulting in significant tax bills made worse by the catch-up effect of a large self assessment balancing payment plus payments on account.
  • Knowing of the above, the partnership year end was returned to 30 April, which created some new overlap profits, but it also had two significant benefits:
    • It deferred payment of significant amounts of tax by 12 months, creating positive cash flow and allowing the business to get its tax provisioning in check; and
    • It pushed profits into a later tax year, giving the opportunity to undertake some income tax planning and reduce the deferred tax liabilities.

Tip – the rules creating and utilising overlap profits can be used to your advantage, particularly if we have visibility on how your business is performing / forecast to perform.  If there is likely to be a sudden change in business profitability, it is always worth contacting us to see whether a change of year end would be in your favour.

We do hope the two tips above will be of interest and do feel free to contact us if you have any queries or would like any advice on your own situation.